How Stock Markets “Crash and Learn”

Those who cannot remember the past are condemned to repeat it. So says Santayana, and so says every stock market professional who’s lived through a stock or stock market crash. The hard truth is that nobody knows what the future might bring, which is why risk management (which Spiking has discussed in a previous post) and good investing habits are vital to an investor’s success.

When a stock market crash happens, there are many things investors can learn, many of which are applicable even when the market is on the up and up. Spiking takes a look at some of these valuable lessons to help investors make smart investment decisions regardless of the state the stock market is in.

A Quick Look Back

A stock market crash, as defined by BusinessDictionary, is a steep and rapid decline in share prices on a stock exchange caused by panic selling. The definition also says crashes are usually triggered by some unexpected event causing investors to lose confidence. Fear worsens the situation, which can last for months or even years.

BusinessDictionary’s examples are the New York Stock Exchange’s 1929 crash, which saw the loss of USD14 billion, and its 1987 crash, where about USD500 billion was lost.

An Opportunity to Learn

Thankfully, today’s investor doesn’t have to experience a stock market crash first hand to be able to learn from one. Indeed, just knowing that crashes, and other unfortunate events can and do happen at the bourse enables investors to prepare accordingly. Here are some “crash-tested” nuggets of wisdom for investors compiled from SparkFin, Forbes and MarketWatch.

1. Don’t assume a stock couldn’t possibly go any lower. During the 1987 crash, AKA Black Monday, SparkFin notes the Dow Jones Industrial Average dropped by 22.61%. On the Wednesday before it, the market had fallen by 3.8%. The next day saw a decline of 2.4%, and Friday had gone even lower by 4.6%.

On each of those days, buyers bought stocks assuming that the market would go back up the next day, or that the market couldn’t possibly go any lower. Then came Black Monday.

2. Think twice about avoiding “expensive” stocks. SparkFin also points out that stock prices are only cheap or expensive compared to its future performance. Unless they have a foolproof crystal ball, investors should therefore not be too hasty about always steering clear of stocks that seem to be pricey.

3. Don’t be too quick to believe doomsayers. SparkFin suggests that making stock market crash predictions is very much like making earthquake predictions — it is not an exact science. There has been, and there currently is no shortage of people who say a crash is just around the corner. Investors would therefore do well to take every prediction with a grain of salt.

If investors were to plan their investment activities around avoiding an “imminent” crash, they would end up staying out of the market most of the time. This in turn means missing out on investment opportunities.

4. Think twice before following “expert” advice. It can be tough figuring out who the “real” experts even are, sometimes. But whether these experts really are experts or not, what they say investors should do, isn’t necessarily what should be done. Examples of such “expert” advice might be to invest all of one’s funds in bonds, or selling all of one’s stocks and hoarding the cash.

5. Make sure you have cash on the sidelines. It’s a good idea to have some funds ready to invest after a crash or any negative event. And a good way to do this is to regularly sell any underperforming stocks in one’s portfolio. This way, a cash reserve is maintained while retaining only the best stocks.

An investor can then divide that reserve into 12 equal parts, each of which is to be invested every month as soon as the crash or unfortunate event has run its course. Sticking to this method will enable an investor to buy stocks at a good average price ahead of the market rebound, and keep that investor from trying to figure out the exact bottom of the crash.

6. Don’t be a “fence-sitting strategist”. Either an investor stays in the market for the long term, or has a plan ready for exiting the market in the event of a crash or anything similar. An investor who chooses a long-term investment strategy is usually one who has time on his side, and is sure he won’t be needing any of the funds he has allotted to the market. This investor is content to stay in the market come heck or high water.

On the other hand, investors who would much rather prefer to leave the market as soon as the chips are down, must have a plan for doing so. An example of such a plan would be to fix a certain percentage as an indicator; like if a stock falls below X% or if one’s portfolio loses more than Y%.

SparkFin warns that investors who do not have either a long-term or exit-on-demand strategy, are the ones who are most likely to sell all their shares at the bottom of the market.

7. Don’t hang on to stocks forever. Earlier this year, Forbes contributor Adam Sarhan focused on the fall of Valeant Pharmaceuticals stock by more than 45% — from a share price of USED263.81, it plunged to a price of USD35.10.

Sarhan says while this does not mean a stock won’t ever soar from there again, it is a good illustration of the rule which states that even the “greatest” stocks need to be sold, someday. In this vein, he also says falling in love with their investments, even when they are losing money, is a common mistake that many investors make. The sooner these investors admits their mistakes, the better.

8. Don’t take risk management for granted. Sarhan also says that every major loss in Wall Street history could have been avoided if investors respected risk. He adds that a successful investor is one who knows how to manage risk better than others. No matter what kind of background, investment strategy, preferences or objective an investor has, an investor will be successful if he gains more than he loses.

9. Keep calm (even if others don’t) and carry on. Wallace Witkowski of MarketWatch quotes a mutual series funds CEO as saying that investors have to have confidence in their portfolio choices. It’s impossible for market conditions to be ideal all the time, so it’s important for investors to have a portfolio they can believe in even when times get tough.

10. Use the crash as a shopping op. Black Mondays may not happen every day but crashes do happen quite often. Witkowski also quoted an exec from the American Association of Individual Investors as saying that there are investors who used the 1987 crash as an opportunity to buy stocks.

When large-cap stock prices went up by 12% in 1988, and by 27% the following year, these investors took full advantage of these recoveries. Today’s investors shouldn’t wait for the market to crash to be able to do the same. Witkowski quotes a Barrack Yard Advisor principal as saying investors should therefore make a shopping list of companies they would like to own, and use extreme market volatility to their advantage.

An investor’s best friend

Staying up to date on any and all market activity, as well as the events that could affect it, is a must for the serious stock market investor. Whether the market is tossing stocks upward with a horned head or swiping stocks downward with extended claws, investors need to be ready to move at a moment’s notice.

Spiking keeps investors up to date in real time with the activity taking place on the Singapore Exchange. By sending Spiking app users verified trading information on every stock spiking on the SGX, Spiking helps these users make informed trading decisions based on fact rather than hearsay.

Spiking also tracks the buying and selling activity of more than 8,000 sophisticated Singaporean investors. Spiking app users can take investment cues from the updates on these activities when planning their next SGX moves.

Visit the Spiking app homepage and find out how Spiking can help fortify your portfolio against stock crashes and other unforeseen events today.